Macroscope | Trade war with the US shows China needs a new market-driven model for monetary policy

It is time for China to show more monetary mettle. Striking the right balance on interest rates between China’s highly industrialised economy while meeting the rest of the nation’s needs is like mission impossible. Depending on your vantage point, interest rates are either too high or too low, leaving the Goldilocks ideal hard to fix. Around the world, central bankers share a similar dilemma with the same problem. World growth is slowing and more policy stimulus is needed. 

The People’s Bank of China has its work cut out, especially since the economy is at greater risk this year of missing the government’s growth target of around 6.5 per cent. And, given the way the US-China trade war seems to be damaging China’s domestic economy, Beijing might be lucky to see growth much above 5 per cent next year. To avoid a deeper crisis, China must ease monetary policy with an interest rate cut as quickly as possible.

Forget what the Fed is doing, ratcheting US rates to more “normal” levels, the signs are that the world could be heading into another major meltdown and steps must be taken soon to help insulate China’s economy from the fallout. The collapse in global share values around the world in the past few weeks is not simply a correction, but symptomatic of a deeper loss of confidence due to growing concerns about the damage to world trade and its threat to global economic activity.

America may be fine thanks to the impact of US President Donald Trump’s explosive fiscal stimulus programme but question marks remain over China, given its sensitivity to export multiplier effects as world trade flows suffer. In a world where multilateralism is under attack and “America first” policies are taking their toll, Beijing needs to take unilateral action of its own. The signs are that China’s fiscal and monetary initiatives both need serious revision as a sharp squeeze seems under way.

China’s underlying domestic credit expansion and government spending growth are both slowing down at a time when the economy is crying out for more. This is piling added pressure on the PBOC to take the strain. The central bank is heading in the right direction, having recently cut the banks’ reserve requirement by 1 percentage point to inject more cash into the banking system and ease lending conditions. Another interest rate cut worth half a percentage point would not go amiss, either.